International | Mar 11 2009
By Andrew Nelson
China is heading into 2009 with a growing trade surplus and if the numbers are right, the first two months of the year saw a US$46bn surplus, compared to just US$29bn in the first two months of 2008. Standard Chartered’s head of research for China, Stephen Green, finds this development both odd and worrying.
He finds it odd because the collapse of global demand was meant to push China’s massive trade surplus down and he finds it worrying because just the opposite needs to happen in order to help achieve a global rebalancing of sorts and to allay concerns about increasing protectionism in the West. The good news is, Green thinks the trend will not continue.
The bigger surplus is due in short to a fall in non-processing imports, that is the type of imports that are not fed back into goods that are exported. This would include things such as energy, raw materials, and machinery. This shortage in non-processing imports, notes Green, is being driven by a combination of a price shock from the higher cost of goods through the first half of 2008 and a collapse in demand from Q408.
The first thing to sort out, says Green, is what has happened to processing trade, which are imported components and exports that are made with a significant proportion of imported content. This trade is driven mostly by demand from the G3, where there has been a drastic slowdown, which has turned out to be much sharper than in either of the last two global downturns. This is now carrying into 2009 and while the processing trade surplus did increase a little in Q4, because processing imports slowed faster than exports as inventories were drawn down, the effect on the overall surplus is small and will likely be temporary, predicts Green.
Smaller imports for China now mean smaller exports in the future, points out Green. It’s no wonder then that the decline in non-processing imports has now caused a spike in the non-processing trade surplus.
The question Green poses is: Why did imports drop like this? The answer: It was a combination of prices and volumes.
In December, real exports decreased by 5%. This leads Green to think that the bigger surplus did not actually come from China’s exports, which were thought to be helped along by artificial policy support flowing into global markets. Rather, notes Green, it was caused by a demand shock in China’s commodity-intensive industrial economy, combined with sudden price adjustments in those same commodities.
Where does this all position us for 2009?
Taking a look at the global picture, Green thinks IMF forecasts for global growth at 0.5% for 2009, with global imports falling 2.8% is an overly optimistic view. Standard Chartered is forecasting US economy contraction of 3.0%, the Eurozone shrinking by 2.0%, and Japan contracting by 3.2% in 2009. In such an environment, notes Green, trading nations will suffer. But, by how much?
Back in 1998-99 and 2001-02, the last two big slowdowns, China was also contending with a recessionary global economy. But on those occasions, China’s processing held up well. It didn’t grow, but more importantly, it did not collapse as it is doing now. That means this time around, things are very different. The severity of the contraction is much greater, meaning a significant decline in processing trade is likely in 2009, with Green expecting a 15% drop in processing trade this year.
The effect on the trade surplus will likely be minimal, which is partly just a mechanical effect. Green notes the more processing you do, the more value you add onshore, and the more surplus you create. However, there is a sharp rise in the ratio of the processing surplus to the value of the imported materials to deal with. Back in 2000, US$100 worth of processing imports generated exports of US$150. Now, the same amount of imports generates US$180 of exports, a 20% increase.
Why is this so? Well Green thinks much of it is due to CNY appreciation against the USD. The CNY1,500 monthly assembly line salary was equivalent to US$180 in 2000, but now it is at US$220, a 22% increase in the dollar cost. And the same principle inflates the USD price of other onshore costs, he notes. This means the dollar increase in the surplus washes out in CNY terms.
In terms of non-processing trade, things are always much harder to call, says Green. On the import side, it consists mostly of raw materials like iron ore, oil, coal, and copper, which mostly end up in domestic investment projects or are consumed in industrial activity. In fact, the last time the government boosted its building programme, imports reacted. While Green doesn’t expect a simple repeat this time around, he suspects there will be demand growth, it just won’t be as strong.
He notes the last few years have seen some significant investment in infrastructure and heavy industrials, which means the base of demand is considerably higher now than it was. This leads him to predict that some commodities, like soybeans, should see relatively stable demand growth in real terms. Some others however, like iron ore, will be heavily dependent upon the ultimate outcome of China’s prospective fiscal packages.
There are other factors to consider as well, says Green, not least of which is the adjustment in commodity prices. At current prices, there is more incentive to import iron ore than to use relatively expensive domestic sources. For this reason, some think that iron ore import volumes will be up 10-15% this year, points out Green. And that’s even if annual production of steel falls. In the case of copper, China prices are still higher than global prices, meaning that importing large quantities will still make sense.
On the export side, notes Green, non-processing manufacturers face the same contracting global economy as their processing peers. Although Green thinks they can probably still build market share in this environment given their cost structures. They did better than processing exporters in the 2001 global slowdown.
On top of this, public works-focused stimulus around the world should also provide some support to exporters of construction equipment and other related products, while at the same time, lower commodity prices should feed through and allow many to cut their prices. This in turn will reverse one of the main factors that caused export prices to rise over 2007-08.
All up, Standard Chartered expects a 25% year-on-year decline in non-processing imports in 2009 in nominal terms, but only around 7% in real terms, while non-processing exports in 2009 should book about a 10% decline. On these numbers, this points to a trade surplus of around US$366bn and a current account surplus of US$406bn, or about 8.2% of forecast 2009 GDP. If Green is right, this will actually substantiate a small improvement in China’s external imbalance.
The capital account, which Green notes has also been in large surplus in recent years, is likely to experience a big downward adjustment. He predicts speculative funds will continue to exit and given foreign direct investment has slowed dramatically and commodity prices are significantly lower, he thinks 2009 should be a significant year of outward direct investment. All up, he predicts that the capital account will be basically in balance in 2009.